Carried Interest

Carried Interest in Private Equity

Carried interest — commonly called “carry” — is the share of investment profits that a private equity fund manager receives as performance compensation. It is the primary way in which private equity General Partners (GPs) are rewarded for generating returns above an agreed threshold, and it is one of the most significant components of compensation for senior professionals in the private equity industry. Understanding how carried interest is structured, calculated and taxed is essential for CFOs and Finance Directors operating in or around the private equity sector, for finance professionals considering roles at PE firms, and for management teams of PE-backed businesses who want to understand how their investor’s economics work. Adrian Lawrence FCA, founder of FD Capital and a Fellow of the ICAEW, leads our senior finance recruitment practice. For the management equity incentive that PE-backed businesses use to align their leadership teams, see our separate Sweet Equity page.

What Is Carried Interest?

Carried interest is typically 20% of the profits generated by a private equity fund above a predetermined return threshold known as the hurdle rate or preferred return. The hurdle rate is usually set at 8% per annum — meaning the fund’s Limited Partners (LPs, the institutional investors who provide the capital) must receive an 8% annual return on their investment before the GP begins to receive any carried interest.

Once the hurdle rate is met, most PE fund structures include a “catch-up” provision that allows the GP to receive 100% of additional profits until the GP has received 20% of the total profits to date. After the catch-up, profits are split 80% to LPs and 20% to the GP for the remainder of the fund’s life. This 20% carried interest split between the LP and GP is the standard “2 and 20” structure — combined with a 2% annual management fee on committed capital — that has characterised the PE industry for decades, though variations are increasingly common.

How Carried Interest Is Calculated — A Simplified Example

A PE fund raises £500 million from LPs. The fund invests across multiple portfolio companies over a 4–5 year investment period and then exits those investments over a further 3–5 years, targeting a 3× multiple on invested capital (MOIC) over the fund’s life.

If the fund returns £1.5 billion to investors (a 3× MOIC), the gross profit is £1 billion. After returning the LPs’ original £500 million capital and the 8% preferred return (approximately £240 million on a 5-year basis), the remaining profit is split between the catch-up and the 80/20 distribution. The GP’s carried interest in this scenario would be approximately £150–£180 million, depending on the precise structure and timeline.

This carry is typically distributed to the fund’s investment professionals according to an internal carry allocation that reflects seniority, tenure, and contribution. A senior Partner might receive 10–15% of the GP’s total carry pool; a Principal 3–7%; a Vice President 1–3%. These allocations vest over time and are subject to clawback provisions if the fund underperforms later investments.

Carried Interest vs Management Fee — The Key Distinction

The management fee (typically 2% per annum on committed capital during the investment period, stepping down to 1.5–1.75% on invested capital during the harvest period) is paid to the GP regardless of performance. It covers operating costs — salaries, office, deal origination — but generates limited upside for investment professionals at the fund level.

The carried interest is performance-contingent. It is earned only if the fund generates returns above the hurdle rate and is where the transformative wealth creation for senior PE professionals occurs. This is why carry allocation — and the terms on which it vests — is the most important component of compensation negotiation for anyone joining a private equity firm at a senior level.

Carried Interest Taxation in the UK

The tax treatment of carried interest in the UK has been subject to significant policy attention and regulatory change. Carried interest received by UK-based PE professionals is subject to capital gains tax (CGT) rather than income tax, provided certain conditions are met — principally that the underlying fund holds its investments for a qualifying period. HMRC’s carried interest rules set out the conditions for this treatment.

The distinction between income and capital treatment is financially significant: income tax at 45% (plus National Insurance contributions) versus capital gains tax at 28% (on residential property) or — for most PE carry on non-property investments — the Investment Manager Exemption rate, which has been the subject of ongoing HMRC and HM Treasury scrutiny. The November 2024 Budget increased the CGT rate applicable to carried interest from 28% to 32% from April 2025, with further reforms to the carried interest regime under a new ‘Investment Manager Exemption’ framework expected from April 2026 onwards.

CFOs and Finance Directors at PE fund managers have responsibility for ensuring the fund’s carry structures comply with current HMRC requirements and that carry pool allocations and distributions are correctly documented and reported. This is a specialist area requiring both tax and fund accounting expertise.

Note: Tax rules change frequently and the above is for general informational context only. FD Capital is not a tax adviser — please consult a specialist tax adviser for guidance on your specific situation.

Clawback Provisions

Most PE fund carried interest arrangements include a clawback provision — an obligation on the GP (and often individual carry holders) to return previously distributed carry if the fund as a whole does not achieve the hurdle rate by the end of its life. Clawback typically arises when early successful exits generate carry distributions, but later investments in the same fund underperform and reduce the fund’s overall return below the threshold.

For senior finance professionals holding carried interest, clawback represents a contingent liability that must be tracked and accounted for. Fund CFOs are responsible for maintaining the clawback calculations, ensuring distributions are structured to preserve the LP’s ability to recover excess carry, and advising carry holders on the implications of clawback for their personal tax and financial planning.

Carried Interest vs Sweet Equity — The Essential Distinction

These two terms are frequently confused but describe entirely separate mechanisms used in different contexts.

Carried interest operates at the fund level — it is the GP’s share of profits on the fund’s overall portfolio of investments. It is earned by the private equity firm’s investment professionals, not by the management teams of the individual portfolio companies the fund invests in.

Sweet equity operates at the portfolio company level — it is the ordinary share equity granted to the management team of a PE-backed company, usually structured to sit above a preference stack so that it provides leveraged upside on exit. Management teams earn sweet equity by growing the business to a successful exit, not by running a fund.

A Finance Director in a PE-backed business may hold sweet equity in their employer and simultaneously understand that the PE fund manager backing their business earns carried interest on the fund’s overall performance. These are two separate equity structures serving different purposes — one aligns management with the portfolio company’s exit value; the other aligns the GP with the fund’s overall return to LPs.

Finance Roles in Private Equity and Fund Management

FD Capital places senior finance professionals across the private equity ecosystem — both within PE fund managers and in PE-backed portfolio companies. Finance roles in PE fund management include the Fund CFO (responsible for fund accounting, LP reporting, tax compliance and carry pool administration), the Head of Finance, and specialist roles in fund operations, valuations and finance transformation. For portfolio company roles see our Private Equity FD page. For executive-level PE fund placement see our CFO Executive Search practice.

Related Private Equity and Senior Finance Services

Related pages: Sweet Equity | Private Equity Finance | Private Equity FD | EMI Scheme | Fractional CFO | CFO Executive Search | Exit-Ready CFO & FD | Business Exit Preparation | NED Recruitment